Unfortunately, options traders, changes may be afoot in the trading world, and they may not be advantageous ones. Several of us have written about the proposed trader's tax, a tax that some feel is unlikely to be passed while others think may be looming in our future. However, a greater--if, hopefully, temporary--change has already been put into effect.
The SEC and/or FINRA, the Financial Industry Regulatory Authority, have audited some clearing houses for options trades. The result has been a requirement that the brokerages using those clearing houses return to a sort of "letter of the law" interpretation of margining rules rather than the industry standards that have been in place for a number of years.
Think-or-swim (TOS) is one of the brokerage houses that has been impacted. When speaking to Sheridan Mentoring students, TOS management asserted that the brokerage itself has not been audited, nor is it alone in having margining rules that it considers antiquated imposed upon its clients. Some TOS clients with double diagonals and unbalanced (by number of contracts or distance between strikes on the put and call side) iron condors and butterflies have been receiving margin calls if they do not have enough cash left in the account to suddenly margin both sides. TOS and presumably other brokerage houses have been fighting the return to old standards for margining rather than a reliance on what has become an industry standard.
Perhaps you believe that a such a change in margin requirements should be accomplished only after notifying all brokerage clients and only after a sufficient period of time had elapsed so that no current trades are impacted. After all, those trades were entered under the understanding that different and perhaps more lenient interpretations of margin rules were in place. That would seem fair and logical.
However, that's not the way this whole margin-call thing works. Remember, this wasn't a TOS decision, but one imposed upon them and perhaps other brokerages by FINRA. Perhaps you recently received your brokerage's once-a-year disclosure for options traders or viewed it online. According to SEC Release No. 34-60437: File No. SR-FINRA-2009-052, published on August 5, 2009, your brokerage's disclosure was required to include language substantially similar to the following two paragraphs:
"The firm can increase its "house" maintenance margin requirements at any time and is not required to provide you advance written notice. These changes in firm policy often take effect immediately and may result in the issuance of a maintenance margin call. Your failure to satisfy the call may cause the member to liquidate or sell securities in your account(s).
"You are not entitled to an extension of time on a margin call. While an extension of time to meet margin requirements may be available to customers under certain conditions, a customer does not have a right to the extension."
Unless you receive such a margin call or are otherwise alerted by your brokerage of the change, you may not know whether your brokerage has been impacted by this return to old interpretations of margin rules. Nor can you necessarily trust your trading platform to be accurately showing the required margin.
TOS, of course, could not, overnight, update its software on a platform that was considered one of the best in the industry. Clients are still putting on positions in which the buying-power effect does not show the double margining requirements that now apply on some positions, particularly on double diagonals. Those clients may be surprised when the next day after putting on a position with a supposed buying-power effect that was smaller than the available cash, they've received a margin call. Neither did TOS send out a blanket email to all clients notifying them of the sudden change. At least, I did not receive such an email and neither did some trading friends, and, since I always leave plenty of cash in my accounts, I wouldn't have had a margin call to alert me to the change. TOS is actively fighting the change and feels that few clients have so far been impacted. Perhaps that's why no blanket email has been sent to clients.
So, now that we have some of the history of recent developments behind us, what are those old standards to which some brokerages must return, at least temporarily? In its introduction to its 41-page manual, "Chicago Board Options Exchange Margin Manual,", the CBOE assert that "strategy-based margin rules have been applied to option customers' positions for more than three decades." It seems that some of the rules being applied have not kept up with those accepted industry standards that TOS management has referenced, industry standards that were being applied when standardized options were just barely in existence.
This strategy-based margin is the type of margin that we have in our Reg T accounts, while a different standard is applied to those who are eligible for and have opted for customer portfolio margining. Not all accounts are eligible for the more lenient customer portfolio margining, however. My Options 101 article, "Customer Portfolio Margining," describes some of the requirements as well as details some of the pros and cons of customer portfolio margining.
For those whose accounts aren't large enough or eligible for customer portfolio margining, the strategy-based Reg-T type margining rules will apply. That CBOE document doesn't specifically address all options strategies. The document notes that is "is not intended to be an all-encompassing restatement of Federal Reserve Board and Exchange margin rules." For example, it doesn't mention iron condors, a type of trade popular among many of our subscribers. Fortunately--or unfortunately for many--another CBOE document does specifically address this strategy. A 2007 document, "Margin Requirements for Sample Options-based Positions," sets out some examples. Scary examples. Page down to the "Short Iron Condor" section, and you'll find that while margin is withheld on only one side of an IBM iron condor, margin is withheld for both sides on a "Stock Index/ETF Options Strategy" iron condor, such as one on the SPX. Few brokerage houses have been requiring margin on both sides. I know the brokerage house from which I place my RUT, SPX and OEX/XEO iron condors has not been.
So, what are we options traders to do? First, unless and until new margin rules are rewritten, we must be aware that FINRA may at any time require a strict interpretation of margin requirements from clearing houses and the brokerages that use them, rather than relying on the more lenient industry standards that have been in effect for a while. We can hope that the codes will be rewritten and this will pass, but we ought to consider the possibility that some of our trades might suddenly require double margining, particularly if we're trading complex strategies that employ options in indices and ETF's or if we're trading strategies that are unbalanced in any way. If I'm worried about the downside risk after a strong run up, and decide to create a position that has 40 RUT bear call spreads but only 20 RUT bull put spreads, and if my brokerage is suddenly required to return to old interpretations, I'm going to have $60,000 minus the credit I received plus commissions and fees withheld, rather than the $40,000 that would have been true until recently.
I think it's imperative that we all keep plenty of cash in our accounts. I've long made it a practice to break my trading accounts into thirds, with one-third for front-month trades, one-third for back-month ones in case they happen to overlap, as they do occasionally, and one-third available for adjustments. In most months, I typically have at least half to two-thirds of the account in cash. I would have been lucky enough to have avoided a margin call if double margin had been suddenly required a couple of weeks ago, when these problems first began surfacing. In my opinion, anyone with a Reg T account should perhaps be careful for the time being, as we won't be sure when our own brokerage might have such rules imposed on them, no matter how considerate and knowledgeable they've been until now. Talk to your brokers or the trading desks at your brokerages to ascertain their feelings about this issue.
Some traders with large enough accounts might consider moving to customer portfolio margining, too, as I'm doing. FINRA has pushed me toward taking this step despite some minor reservations I've had. The yields on trades are larger with customer portfolio margining, since less money is withheld for each trade, and, if these old interpretations of margining rules are not changed, that will be doubly true. A trade that now requires double the margin of course produces half the yield that it did in the past.
This information is not meant to alarm subscribers but just to alert you. Perhaps no changes have been instituted at your brokerage and none ever will be, as saner heads prevail upon the FINRA to revise their thinking. If you can believe this return to the old interpretations impacts individual traders, you can believe that it impacts brokerages more than it does us. TOS management and others are fighting the imposition of these old rules and for the more lenient accepted industry standards. You can believe they're fighting harder and with more ammunition than we individual traders can do. I'll update as I find out more.